Real Output Fails to Signal National Tax Capacity

Australia's most commonly used measure of economic well being is no longer synonymous with the growth of the nation's tax base.

For many decades, Australians have been persuaded to take movements in gross domestic product as their prime indicator of economic progress. GDP is the cake to be shared among all those vying for a slice. More strongly growing output (real GDP) is a prerequisite for higher living standards.

In contrast, the amount of national tax revenue is a function of the nominal value of the economy, not real output. Taxes are usually defined as a percentage of income or a percentage of the value of sales or production, for example.

Tax collectors are typically indifferent between higher output and higher prices in striking the amount they raise. Either will do the job. But having both output and prices contributing will do the job best of all especially in combination with progressive income tax structures.

Over the eight years to 2007, taxes on income grew at 6.6% a year, just on twice the 3.3% rate of real GDP growth, according to the national accounts data published by the Australian Bureau of Statistics. Over the last three years, output growth of 2.9% a year translated into an 8.3% a year growth rate in taxes on income.

Over the very long haul - since 1960 - an average 3.6% output growth rate has translated into 10.0% growth in taxes on income and 9.4% growth in the value of taxes on production and imports.

Over the year to the December quarter of 2012, real GDP (based on expenditure) rose by 3.1%. This was slightly better than the 2.9% rate of growth experienced over the last three years and not greatly out of line with the 3.3% growth rate over the eight years to 2007.

Naively extrapolating the apparent historical tax-output relationship would have suggested growth in tax revenue in 2012 of 6-7%, perhaps more. Alas, the number was slightly less than 1%.

A five percentage point shortfall in the government tax revenue growth rate equates to as much as $12 billion annually in revenue at risk. That's a lot of education reform or hospital funding.

Historically, nominal GDP (the value of output and hence incomes) has outstripped the growth in real GDP. Over the eight years to 2007, nominal GDP grew by 7.4% a year, more than twice the pace of real GDP growth.

The risk of naive extrapolation of economic outcomes was abundantly evident during 2012. Unusually, nominal GDP grew by only 2.0% - much less than real GDP.

Lower prices are supposed to be beneficial. Improved purchasing power equates to higher standards of living. But lower prices play havoc with the tax base.

Weak tax receipts do not necessarily mean anyone is shirking their responsibilities. It does not mean mining billionaires or big corporations are avoiding their fair shares (although, no doubt, some might try).

Unfortunately, this might be hard for the average voter to grasp fully. As Mr. and Mrs. Average go shopping, they see a different picture. The value of consumption spending rose by 5.3% over 2012 but real consumption grew just 2.8%. In their world, rising prices are still eating away at living standards.

The implications of these numbers are political dynamite. If the most effective taxes are ultimately those directed at areas of the economy where values are rising most quickly, consumption spending is where the greatest leverage is to be found at this point in Australia's economic history.

This is not necessarily making a case for an expansion of the GST but, more simply, an illustration of the complexity of the policy problem confronting whichever parties are elected later this year.

Cultivated with care, a reasonable electorate may be prepared to think about what this means for the choice between spending and taxes. But if Messrs Gillard and Abbott persist with glib catch phrases about poor economic management or continue creating false expectations based on Australia's real growth rate, the fundamental constraint will be missed.

Anyone daring to propose more from taxes on spending or income to escape this policy bind will be testing fate in a way that even the most skilled and best loved politicians do only rarely.

So, we can be reasonably certain that the underlying economic relationships will be ducked as the tax-spending conversation occurs between now and 14 September.

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